Watch HowardCohodas Trade Index Options Credit Spreads

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Old Dec 9, 2010, 10:02am   #106
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

HowardCohodas started this thread Trading plan for Thu, 9 DEC 2010 from Dashboard

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Opportunity
    Incomplete Iron Condors
        13 
DEC5 10 SPX
        17 
JAN 11  SPX
        22 
JAN 11  NDX

    Roll Candidates
        12.P 
DEC 10  PUT SPX
        13.P 
DEC5 10 PUT SPX

Jeopardy
    All Weeklies that expire today
        Decision to bail 
or let expire by 3:45 EST
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Old Dec 9, 2010, 8:02pm   #107
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

Hi Howard,

I appreciate how open you are about your intentions in this journal. In light of that, I'd like to ask a few questions and perhaps offer some constructive criticism in response (if I'm able to).

Is it fair to say that you believe your positive expectation at trade inception comes from the ability of the TOS probability calculation to give you a more accurate prediction of the index's future price distribution than the distribution expected by the market?

If yes, (and I don't mean this to sound sarcastic) isn't that a little hard to believe? Some of the best minds in academia and on wall street have been trying to accurately model this for decades (unsuccessfully). Not only that, but this would also be saying that the TOS calc is so much better than the market's estimate that the discrepancy is large enough to overcome commissions and bid/ask spread.

If no, then what is your source of positive expectation? Or said another way, what is causing the market inefficiency that is mispricing these option constructs? Is it that you believe the market systematically overprices risk premium?

Of course, you are under no obligation to address any of these but i think these could begin a discussion that may help as you consider trade evaluation, risk management, marketing, and perhaps the approach overall.
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Old Dec 9, 2010, 8:08pm   #108
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

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Originally Posted by bs2167 View Post
Hi Howard,

I appreciate how open you are about your intentions in this journal. In light of that, I'd like to ask a few questions and perhaps offer some constructive criticism in response (if I'm able to).
Thank you.

I believe some of your questions have been answered previously. Kindly read, or reread the initial post and the FAQ and if I have failed to adequately explain my thinking, I'll try to expand on it.

I look forward to a good Socratic dialog on my methods. We all learn something from it.
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Old Dec 10, 2010, 12:09am   #109
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

Only have a minute, but quickly here's what I think:

1. Options for the most part are fairly priced
2. Therefore, in order to have positive expectation in a non-directional option trade(s), one must be able to predict whether future volatility will be higher or lower than the market is currently pricing in. I highly doubt the TOS probability calculator has that capabilty - world's best kept secret if so.
3. Therefore by methodically selling cheap gamma every month, I think you have zero expectation before comm/slippage but considerably negative expectation after bid/ask and commissions are factored in.

Do you agree on these points?
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Old Dec 10, 2010, 4:38am   #110
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

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Originally Posted by bs2167 View Post
Only have a minute, but quickly here's what I think:

1. Options for the most part are fairly priced
2. Therefore, in order to have positive expectation in a non-directional option trade(s), one must be able to predict whether future volatility will be higher or lower than the market is currently pricing in. I highly doubt the TOS probability calculator has that capabilty - world's best kept secret if so.
3. Therefore by methodically selling cheap gamma every month, I think you have zero expectation before comm/slippage but considerably negative expectation after bid/ask and commissions are factored in.

Do you agree on these points?
1. Yes, but irrelevant to what I do.

2. Selling credit spreads, means that you are selling time high and buying is back low. Time will pass, so time value must go to zero. No magic here.

The TOS calculation of probability of touching is unrelated to anything you mention. And their model is very close to the one I developed. It serves my purposes perfectly, i.e. estimating the likelihood that a given strike would be reached during the period of time I would be in the spread.

3. I have no idea what you are getting at.
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Old Dec 10, 2010, 6:19am   #111
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

2. You are selling risk which is a function of time, not time itself. And there is absolutely no guarantee that you will be "buying it back low".

1. It absolutely is relevant as its the amount that you're compensated for the risk you are selling.

----------------------------------------------------------------

Take this simple example:

1. 60 days of Risk is worth $10.00.

2. With 60 days to expiration option market makers bid $9.00 and offer $11.00 for this risk.

3. You sell it to them at $9.00 and pay $0.50 in commision. Netting $8.50.

4. Your expectation on this trade at inception is -$1.50

5. 50 days of risk is worth $8.25.

6. If you make it to day 50 without any adverse moves occurring yes you will have positive expectation of $0.25 at that point. But this is a huge IF...you state the certainty of time passing as if there was no risk during the period. In the long run you will lose -$1.50 on average for all these trades.

Where do we disagree in the context of this example?
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Old Dec 10, 2010, 12:08pm   #112
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

HowardCohodas started this thread 09 DEC 2010 Trading Summary
Today was a good and a not so good day. The not so good first.
I had two unforced errors, one benign and one potentially risky. The benign error occurred when I was adding spreads to spread #35 to balance an additional PUT spread that I had added to this options series. When I did not get a fill at my chosen price, I lowered my price to resubmit. When the trade did not appear on the platform, I thought I had canceled rather than cancel and replace. I resubmitted and both filled.

Now my IC was unbalanced again. So I went to add the PUTS to rebalance and I misread the TOS chain column and put on a spread that is far riskier than my rules permit. Of course, I did not spot this until after the market closed when I was updating my journal. This was an unforced error because there were many clues laying around, like the unusual credit I received.

I'm still working on a method to prevent this kind of unforced error besides just a commitment to better focus and discipline.

Four weekly spreads expired today. Three I let expire, and one I bought back to avoid market gap risk.

PHP Code:
44  12/03/10  12/09/10  DEC2 10 NDX CALL  2250  2275  0.750  100%    3.1%    20.C    Expired
43  12
/03/10  12/09/10  DEC2 10 NDX PUT   2100  2125  1.800  100%    7.8%    20.P    Expired
45  12
/03/10  12/09/10  DEC2 10 SPX CALL  1250  1260  0.500   70%    3.7%    21.C    Closed to avoid gap risk
46  12
/03/10  12/09/10  DEC2 10 SPX PUT   1150  1175  0.650  100%    2.7%    21.P    Expired 
Yield Summary
IC 20
Spread 44: 3.1%
Spread 43: 7.8%
As an IC: 11.4%
IC 21
Spread 45: 3.7%
Spread 46: 2.7%
As an IC: 4.8%
IC 12 Developed a roll opportunity
PHP Code:
41  12/01/10            DEC 10  SPX CALL  1265  1270  0.250  (10%)  (0.5%)  12.C
29  11
/09/10  12/09/10  DEC 10  SPX PUT   1125  1130  0.500   90%   10.0%   12.P  Closed with intent to roll
51  12
/09/10            DEC 10  SPX PUT   1190  1195  0.300  (25%)  (1.6%)  12.P  Opened to complete IC 
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Old Dec 10, 2010, 12:10pm   #113
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

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Quote:
Originally Posted by bs2167 View Post
Where do we disagree in the context of this example?
I am unmotivated to explore your thought experiment as it's formulation illustrates that you have not taken the time to study the description I provided of my methods.
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Old Dec 10, 2010, 12:42pm   #114
 
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10 DEC 2010 Trading Plan

HowardCohodas started this thread 10 DEC 2010 Trading Plan from Dashboard

PHP Code:
Opportunity
    Incomplete Iron Condors
        13 
DEC5 10 SPX
        17 
JAN 11  SPX

    Roll Candidates
         8.P
        12.P 
DEC 10  PUT SPX
        13.P 
DEC5 10 PUT SPX
        16.P
        
    
New Spreads
        Funds from margin 
for expired weeklies are made available today and new weeklies are become available for trading

Jeopardy
    Spread 52
the unforced errorshould be reformedat a profit if possible
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Old Dec 10, 2010, 4:35pm   #115
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

Quote:
Originally Posted by HowardCohodas View Post
I am unmotivated to explore your thought experiment as it's formulation illustrates that you have not taken the time to study the description I provided of my methods.
Look Howard, I have read your entire thread - I do have other things I can do with my time, but I'm sincerely trying to help. I'm trying to expose the flaws in your approach in a way that I think you will understand, because quite frankly your options knowledge is extremely limited and you don't accept some very fundamental derivatives concepts.

Putting derivatives fundamentals aside for a moment, ask yourself if what you're proposing makes any logical sense whatsoever. If you have positive expectation following this simple method, why would anyone do the other side of these trades? Zero sum game, no? Why would Wall Street bother hiring all those quants to develop sophisticated strategies if all they had to do was "sell time high" and "buy it back low"? The premise is absurd. I don't think you need options knowledge to recognize that.

This was not a thought experiment, I know what I'm talking about - what you're doing has a very high likelihood of ending badly...I'm just trying to illustrate that in a simple manner. Consider one last analogy that will hopefully resonate. You are acting as a car insurance company. Actuaries agree that over the long run the annual cost to insure a 40 yr old man with a good driving record is $1000/year because once every five years he will drive into a tree and you'll need to cut a check for $5000. However, you decide to sell him a policy for only $800/year. True, you may have a good income for 4 years, but clearly over the long run this is a money losing operation. Now, I think here you would argue that your adjustment strategy makes this a poor analogy. You think that you'll be able to see the tree coming and jump in the car to swerve him away from it...or at least prevent a head-on collision, mitigating damages. And I would argue that your odds of trading your way out of a disastrous drawdown are just about as good as being able to hop in this guys car and steer him away from the tree in time. Why do you think Nassim Taleb is able to sell so many books on the subject? Unpredictable events have time and time again blown up some of the best minds in finance...because they are just that, undpredictable - are you really that talented? On the off chance that you are truly that gifted as a trader, why bother with this condor business...GS would happily pay you $50M to trade directionally.

Brush me off if you'd like, but in my opinion it would not be responsible for you to risk others money at this point without a full appreciation for the risks/economics of what you're proposing. And you certainly didn't ask for this (and I promise to go away after this post), but this would be my recommendation to you:

1. Read Options Pricing and Volatility by Sheldon Natenberg
2. Read one of Taleb's books
3. Read the SPX Credit Trader journal thread on ET (it's long, but some good stuff in there that is very relevant to what you're trying to do)
4. I think after your done with steps 1 -3 you'll be convinced that you don't have an edge. If you wish to work on developing one, Volatility Trading by Euan Sinclair is a good place to start.

Again, my intent here is coming from a good place and I hope you take it as such despite it being a bit harsh in spots. Good luck.
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Old Dec 10, 2010, 4:53pm   #116
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

Quote:
Originally Posted by HowardCohodas View Post
1. Yes, but irrelevant to what I do.

2. Selling credit spreads, means that you are selling time high and buying is back low. Time will pass, so time value must go to zero. No magic here.

The TOS calculation of probability of touching is unrelated to anything you mention. And their model is very close to the one I developed. It serves my purposes perfectly, i.e. estimating the likelihood that a given strike would be reached during the period of time I would be in the spread.

3. I have no idea what you are getting at.
I traded FX options on the sell side for many years. Now I am an "independent trader", I don't actually trade options at all. Why not? Because I don't perceive myself as having any edge in trading them.

If, according to 3., you don't understand terms like gamma, you should NOT be trading options on the short side. Seriously.

A ridiculous amount of guff is written about options, and many misconceptions abound. Nearly all retail punters like to sell gamma (short dated options), because they believe they are "earning time decay". It's utter horse manure. Why do you think anyone BUYS options - are they all idiots?

The other classic line is "most options expire worthless". Well that's true, but it's because most of them start off life as sub-50 delta, so by definition, the majority of options will finish out of the money - it doesn't mean that systematically selling options will make money over time (I believe this is what you're doing).

In my (fairly extensive) experience, the people who make the most money from options are the ones who BUY them. Low delta, cheap options which pay off big time. On the other hand, I've seen several instances of high net worth individuals and hedge funds blow up through consistently selling options.

I know you'll probably disregard this post. That's fine, but try to think about what your edge is. As has been said, options are more or less fairly valued. If you systematically sell them to "earn" premium, you won't make money in the long run. In fact, you'll lose money after bid/ask and commission.

Now, if your VIEW is that implied vol consistently tends to exceed actual vol, then you have a basis for your trades. But you will struggle to find statistical evidence that this is the case.
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Old Dec 10, 2010, 5:27pm   #117
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

HowardCohodas started this thread
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Originally Posted by meanreversion View Post
If, according to 3., you don't understand terms like gamma, you should NOT be trading options on the short side. Seriously.
I have a pretty good understanding of the greeks, but not as good as long time options traders. I was being a bit flippant in my remark. It was not the concept of gamma that I remarking about, but the conclusion part of the statement. "I think that..."

Quote:
Therefore by methodically selling cheap gamma every month, I think you have zero expectation before comm/slippage but considerably negative expectation after bid/ask and commissions are factored in.
I also took umbrage to the what seemed at the time to be a lack of understanding of what I was doing, not only for entry but also for management.

Bottom line... I probably should not be quite so careless in my remarks.
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Old Dec 10, 2010, 5:35pm   #118
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

I've read most of your pertinent posts, so I think I understand what you're doing. I know you've backtested etc. but I still can't deduce your edge. I think it has to be one of three possibilities -

1. You've found a way of evaluating probabilities which is not reflected in option prices (this simply can't be true)
2. There is an element of trend following in your system (is this right?)
3. You have a strong feel for the market and place trades in a discretionary manner, and are able to do this successfully because of your experience (although this is not something you could have backtested, so I'm not sure this is the answer either).

Any thoughts on this?
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Old Dec 10, 2010, 6:16pm   #119
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

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Originally Posted by meanreversion View Post
I've read most of your pertinent posts, so I think I understand what you're doing. I know you've backtested etc. but I still can't deduce your edge. I think it has to be one of three possibilities -

1. You've found a way of evaluating probabilities which is not reflected in option prices (this simply can't be true)
2. There is an element of trend following in your system (is this right?)
3. You have a strong feel for the market and place trades in a discretionary manner, and are able to do this successfully because of your experience (although this is not something you could have backtested, so I'm not sure this is the answer either).

Any thoughts on this?
Your post arrived with perfect timing as I was just about to address my understanding of my edge in response to other parts of your previous post.

First, the frightening part. I am completely agnostic regarding view of market direction.

Second, there is a part of trend following in the way I manage the spreads, but not in their setup. Thus a trending market usually makes me considerably more money than a sideways market. In a trending market, I may roll one side or the other or sometimes both sides of an iron condor a number of times before expiration. In a strongly trending market, I may be forced to abandon one side of the iron condor. So far, a strongly trending market is what I perceive to be my most serious risk element. Therefore, I choose my bail-out point carefully so that I don't wipe out months of profit. I have not yet encountered a market that trended so strongly that I had to take my maximum loss (as opposed to the maximum loss implied by the spread). However in testing, so many roll opportunities presented themselves on the other side of the iron condor, that in most cases the iron condor was still profitable in spite of taking a 20% to 30% (or capital at risk) hit on the losing side.

So, other than exploiting trending, where does my edge come from? My study of options and their uses leads me to believe that there are a huge number of uses too which professional and retail traders put them. And not all uses drive the prices in the same direction. There is a natural tension among their different uses that brings relative order to the market. There have been times that particular uses have driven volatility to extremes, but this appears to be unusual.

Thus the majority of volume is devoted to uses other than spreads. This leaves a nice niche for me to exploit. There are those who ask why would anyone in their right mind take the opposite side of my trade. I think that question displays some ignorance of the options market. It assumes that when I sell a credit spread, both legs are traded with the same person. Why would that be true?

My conclusion is that my edge comes from the way I manage my spreads (and iron condors) and the credits available as a result of the preponderance of option trading not devoted to taking the opposite sides of my spreads.

So have I found the holy grail, or am I in for a huge fall as some here have predicted, or something in between. We'll see.

As long as there is interest in this thread, I will endeavor to continue posting to it, including my screw-ups. I'm unsure what my time availability will be if/when I go through with my ETC program.

BTW, I truly appreciate those that take the time to challenge my assumptions and my methods. Answering the questions has caused me to think much more deeply than I had thought when I started. I think you guys have made me better at what I do.
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Old Dec 10, 2010, 6:23pm   #120
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

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Quote:
Originally Posted by bs2167 View Post
Look Howard, I have read your entire thread - I do have other things I can do with my time, but I'm sincerely trying to help. I'm trying to expose the flaws in your approach in a way that I think you will understand, because quite frankly your options knowledge is extremely limited and you don't accept some very fundamental derivatives concepts.

Putting derivatives fundamentals aside for a moment, ask yourself if what you're proposing makes any logical sense whatsoever. If you have positive expectation following this simple method, why would anyone do the other side of these trades? Zero sum game, no? Why would Wall Street bother hiring all those quants to develop sophisticated strategies if all they had to do was "sell time high" and "buy it back low"? The premise is absurd. I don't think you need options knowledge to recognize that.

<snip>

Again, my intent here is coming from a good place and I hope you take it as such despite it being a bit harsh in spots. Good luck.
Now that you have apparently read the thread, and have targeted your remarks closer to my practice, I can respond in like form.

I take you at your word regarding your motives, and I never take harsh challenges personally. No harm, no foul.

I believe that this response covers some of your concerns. We can then progress from there.
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